Carbon Offsets 101

Carbon Offsets 101

A primer on the hottest

-and trickiest-

topic in climate change.

Carbon offsets have become all the
rage recently: the winter Olympics of 2006 in Turin, Al Gore, the U.S.
country-rock trio Dixie Chicks, and Hollywood actor George Clooney all buy
offsets in an effort to become "carbon neutral." The New Oxford American
Dictionary even chose "carbon neutral" as the Word of the Year for 2006. As
public awareness of the driving role carbon emissions play in climate change becomes
nearly universal, the pressure to take action is increasing and many firms and
individuals who have decided they want to do something about it are purchasing
offsets.

Yet there is a lot of confusion,
ambiguity, and even hype surrounding carbon offsets. What exactly does it mean
to "offset" a ton of carbon dioxide (CO2) emitted into the air? Why does the
price of a ton of CO2 vary wildly from one offset broker to another? What do
you really get for your money? Are offsets just a cheap way to ease the guilt
of shoppers, motorists, and frequent flyers, or can they really contribute to
climate protection in a meaningful way?

The concept is very simple. All
fossil-fuel powered vehicles (as well as fossil-fired power plants and
factories) emit CO2 during operation. Commercial jets are no exception, and
collectively contribute a significant share of global annual emissions. So
let's say you fly on a commercial carrier from Chicago to Amsterdam. You would
use one of the many online carbon calculators to determine your share of the
CO2 emitted by the aircraft. (The best of these calculators will consider such
factors as the total distance, the increased warming impact of emissions at
high altitude, the aircraft type, how full it was, and whether the flight was direct
or involved a stopover, but most are much less sophisticated.) In this example,
you might find that you were responsible for 3.5 tons of CO2 emissions. You
would then pay a carbon offset company for 3.5 tons of CO2 offsets. The company
(or nonprofit organization) would then invest your money in a project meant to
reduce greenhouse gas emissions and you get credit for a share equal to the
carbon you were responsible for on your flight. Because climate change is a
non-localized problem, it doesn't matter where the emissions are reduced.
Greenhouse gases spread evenly throughout the atmosphere and reducing them
anywhere contributes to protecting the climate. The same method can be used to
offset the annual mileage accumulated by an automobile, or the emissions of a
stationary source such as a power plant.

It sounds straightforward enough.
Offsetting promises to offer environmentally conscious consumers a guilt-free
way to continue their current lifestyle while at the same time contributing to
climate protection.

So why do some critics liken
offsetting to buying pardons from the Catholic church in 16th century Europe?

Options

The Intergovernmental Panel on
Climate Change (IPCC) Fourth Assessment Report, published a few months ago,
said unequivocally that climate change is real, it's bad, and it's mostly
humans' fault. To limit global temperature rise to less than 2.0 degrees
Centigrade above the pre-industrial level-a threshold beyond which catastrophic
effects on a global scale become much more likely-the concentration of
atmospheric greenhouse gases has to be stabilized at about 450 parts per
million (ppm). Greenhouse gas concentrations are currently at 382 ppm and
rising about 2 ppm per year. In other words, we need to reduce greenhouse gas
emissions by about 60-80 percent below current global levels-rapidly.

Carbon offset projects can help
meet this challenge. They fall roughly into four categories. Renewable energy
projects-such as solar and wind energy and biodigesters that utilize methane
emissions from manure, agricultural waste, or landfills to generate
electricity-reduce emissions by displacing or replacing fossil-fired energy
sources. Energy efficiency projects, such as low-energy housing and lighting or
efficiency gains in industrial processes, reduce emissions by using less energy
to accomplish the same tasks. Greenhouse gas capture projects capture non-CO2
greenhouse gases from industrial processes (e.g., HFCs) or methane from
agriculture or landfills. And biosequestration projects enhance the biological
uptake of CO2 through forest planting and protection and through land
management practices such as no-till agriculture.

(Another carbon-control
methodology, geosequestration, involves capturing CO2 emitted from coal-fired
power plants and other industrial sources and injecting it into old oil fields,
beneath the sea bed, or into other geologic structures. Geosequestration
technologies are relatively new and are very expensive, and despite strong
interest in them from the coal industry their longterm viability is highly
uncertain. Currently, no carbon offsets from geosequestration projects are
being sold, and this article will not discuss geosequestration further.)

All these approaches can, if
implemented well, lead to the reduction of greenhouse gas emissions or
concentrations, although biosequestration is somewhat controversial. It's
difficult to ensure "permanence"(that newly planted forests remain standing and
are protected) and prevent "leakage" (simply logging other forests instead).
While there are ways to address these issues, there are other problems too:
tree plantations, for instance, might do well in absorbing carbon, but they are
usually monocultures that lack even the most minimal biodiversity. (Old-growth
forests, on the other hand, are a rich web of thousands of plant and animal
species. They also hold large amounts of carbon in their soil and vegetation.
Yet their carbon storage potential is mostly used up, and much of the new
carbon they absorb is offset by carbon that is emitted from decomposing
matter.) Moreover, one recent study suggests that the location of afforestation
or reforestation efforts may be critical: trees planted in high-latitude lands
may replace snow or ice cover and reduce the albedo (reflectivity) of the
surface, thus increasing warming even as they absorb carbon during growth.

Ultimately, if global warming is to
be controlled, a trans­ition away from fossil fuels is imperative. Renewable
energy and energy efficiency projects help us move toward a low carbon economy;
carbon sequestration does not. It seems therefore more important to support
energy projects rather than carbon sequestration projects.

Fairness

Here's where the value and
suitability of carbon offsets begins to get complicated. There are several
issues surrounding carbon offsets, and the way these issues are resolved can
enhance or diminish their value.

For example, does it matter where
offset projects are implemented? The answer is...yes and no. Although it has only
4.5 percent of the world's population, the United States is responsible for 25
percent of global greenhouse emissions. The average American produces twice as
much carbon as a European or Japanese, six times as much as a Chinese and 16
times as much as an Indian. Here is one of the conundrums of carbon offsetting.
Many agree that high-emitting countries should reduce their own emissions, but
many of the carbon offset projects are in developing countries. As noted
earlier, since CO2 spreads evenly throughout the atmosphere it doesn't matter
where a project is located, and the argument is that it makes more economic
sense to reduce emissions where they are cheapest. Since everything is cheaper
where people are poor, carbon offset projects in developing nations make
financial sense. Further, the cheaper it is to reduce emissions, the more, and
more rapidly, emissions reductions can be financed, so this actually makes
environmental sense as well.

But is this fair? Some claim that
carbon projects in developing countries are a form of neocolonialism, that the
rich countries will snatch away all the reductions that are easy and cheap-the
"low-hanging fruit"-and that the poor nations will later have to pay for more
expensive reductions. Serious criticism has been leveled at projects
implemented through the Kyoto Protocol's Clean Development Mechanism (CDM) (see
online glossary at www.worldwatch.org/ww/offsets for definitions of this and
other terms): that they are neither "clean" nor do they lead to "development,"
but on the contrary harm and disenfranchise local people.

However, other observers from both
industrialized and poor nations claim that offset projects can be an amazingly
effective tool to lower carbon emissions and at the same time alleviate poverty
by spurring development in poor countries. Offset projects can have multiple
additional benefits: environmental restoration, infrastructure development,
education and training, and provision of energy services to the poor. Some of
the best offset projects combine the Millennium Development Goals of poverty
reduction with climate protection. For example, the 4.5 megawatt biomass power
project in Malavalli, India, produces electricity with agricultural waste that
used to be burned off or just left on the fields to decay. The project created
500 new fulltime jobs. In order to ensure stakeholder participation, local
farmers were involved in the decision-making process and an NGO was formed to
manage power distribution, billing, and revenue collection. The ash from the
power plant is distributed to the farmers for use as a valuable organic
fertilizer.

There is another reason why it may
be inappropriate to carry out offset projects in rich, high-emitting countries.
Most developed nations have ratified the Kyoto agreement, and 39 of those
(called Annex B countries) have legally binding emissions reduction targets to
meet. If a carbon offset project (say, a wind farm) is implemented by a private
offset company in an Annex B country, the reductions it produces will
automatically be double-counted: the purchasing individual or organization will
count them, but because there is currently no regulatory system permitting
those emissions to be "retired" (taken out of the system then and there), the
reductions will also be counted in that country's greenhouse gas inventory.

Why does this matter? Every Annex B
country has to implement policies and projects to achieve the reductions that
Kyoto mandates. If a company funds an offset project in an Annex B country, the
resulting carbon offsets would need to be retired from that country's national
greenhouse gas inventory in order to avoid double-counting. But to date no
Annex B country has a regulatory system in place that would prevent this kind
of double-counting, which means the private offset project has effectively replaced
another set of emissions reduction measures that the country would have had to
take in order to meet its Kyoto requirements.

Viewed this way, it can be argued
that the wind farm in our hypothetical example does not have any net carbon
benefits. Paradoxically, in countries that have not ratified Kyoto, such as the
United States and Australia, these double-counting issues don't exist at the
national level. They do exist on a more local level, however: if a region,
state, county, or city has enacted an emissions reduction target (even just a
voluntary one), any emissions reductions that are created in that area but then
sold as offsets in the voluntary market should not also be counted in that
jurisdiction's emissions inventory.

Standards and Verification

The arguments for and against
projects funded by rich nations in poor countries are both valid. Only strict
standards, oversight, and verification of projects can ensure that the
additional benefits will outweigh the negative impacts. Understanding the importance
of standards and verification requires a short detour into carbon markets.

Carbon offsets are currently sold
in either mandatory or voluntary markets. In mandatory markets, buyers operate
within a cap-and-trade regime. Cap-and-trade regimes (such as the Kyoto
Protocol, the European Union Emissions Trading Scheme, or the Regional
Greenhouse Gas Initiative launched by several U.S. states) set a total upper
limit on emissions and then either allocate or auction off emissions
allowances-basically, licenses to pollute a certain amount-to interested
buyers. These systems are meant to achieve the greatest emissions reductions at
the least cost, because emitters with cheap options for reducing their
emissions can sell their surplus allowances to emitters with higher reduction
costs. (In a cap-and-trade system, it is crucial that the cap be set
stringently enough so that meaningful reductions can be achieved. If there are
too many allowances, their price will plummet and few reductions will be
achieved because it will be cheaper to buy allowances than to implement
greenhouse gas reductions. This is exactly what happened with the European
Emissions Trading Scheme.)

Voluntary markets, on the other
hand, do not function under a cap-and-trade system, and neither individuals nor
companies are mandated to act. Rather, they choose to offset their emissions
out of concern for the environment or to improve the company's image. Because
there is no cap on emissions, voluntary markets are intrinsically different
from mandatory markets.

In either case, measures that lead
directly to emissions reductions are project-based transactions, which involve
newly created carbon offsets from renewable energy production, energy
efficiency, or carbon sequestration projects. Project-based transactions can be
conducted either within the mandatory Kyoto framework or outside of it in the
voluntary carbon offset market. CDM is one of the project-based mechanisms that
are part of the Kyoto Protocol, and offsets that are created through CDM projects
are called Certified Emissions Reductions (CERs).

In the voluntary market, companies
can sell CERs, or they can opt to sell offsets created outside the CDM, called
Verified Emissions Reductions (VERs).

Carbon projects that are
implemented through the CDM have to go through in-depth review and
verification, meet clearly spelled out standards, and have the reductions
legally guaranteed by a third-party verifier. All CDM emissions reductions are
also recorded in an international registry to ensure that they are only counted
once. The CDM process is quite labor-intensive and bureaucratic, and although
CDM projects are not without flaws, the standards and the processes are quite
robust and the hope is that with time and experience the CDM projects will increase
in number and quality.

Most voluntary offset companies
sell VERs, because CERs are more expensive. VERs are not necessarily of lower
quality than CERs, but there is currently no unified quality standard applied
to all VERs. Third-party verification is not required and therefore no one is
legally responsible for creating the promised reductions. Also, there is no
central registry to prevent double counting.

Since CERs fetch a higher price
than VERs, there are only three reasons why a project developer would opt not
to go though the CDM: 1) the project is in a country that is not a party to
Kyoto (e.g., the United States); 2) the project is so small that it would be
too expensive to go through all the bureaucratic hurdles for CDM certification;
or 3) the type of project is not covered in the CDM procedures (for example,
very decentralized projects, such as light-bulb switching programs, are
currently very difficult to certify under CDM). If a project declines to
register for CDM and does not fall into one of these three categories, it is
probably because it is of lower quality.

In the United States, the offsets
sold in the voluntary market are almost exclusively VERs-and that has provoked
some controversy. One of the main problems with VERs is that, unlike CERs, VERs
are not required to be screened for "additionality"-the most debated topic in
the carbon offset world. It answers a simple question: would the project have
happened anyway, holding everything else constant, if the carbon offsets from
it could not be sold? If the answer is yes, then the project fails the
additionality test. And if a project is going to happen anyway, buyers of its
offsets can't really claim that they are offsetting the emissions they are
trying to neutralize.

The crux of additionality lies in
its application. How do you prove that a project would not have happened
anyway? There are several possible additionality tests. For example, the
regulatory test asks: Is there a law requiring the project, such as legislation
to capture methane at a landfill, or a government-mandated renewable portfolio
standard? If so, the project is nonadditional. Such a regulatory test is easily
applied and all reputable companies in the voluntary offset market require it.
Yet to require only the exclusion of projects that are mandated by law is a
very weak standard, because projects happen for many other reasons too. Wind
farms in the United States, for example, are often built because the available
federal tax credits make them financially viable. So other, more stringent,
additionality tests have to be applied to such projects.

Another test, financial
additionality, means that a carbon project is only financially feasible because
of the revenue from the carbon offsets. The project may have other justifications,
but the anticipated benefits of the carbon offsets have to be a decisive factor
for pursuing it.

RECs

Many of the carbon offsets sold in
the United States began life as Renewable Energy Credits (RECs) (see "Green
Tags," p. 15, for a detailed discussion). They were then converted to carbon
offsets by multiplying them by a factor that accounts for the avoided CO2
emissions. One REC represents the delivery of one megawatthour of renewable
power to the total energy infrastructure, and they can be sold and traded in
both mandatory and voluntary markets. It is important to understand the
difference between "mandatory" or "compliance" RECs and voluntary RECs. Because
mandatory RECs are an instrument for meeting a quota, for example that of a
renewable portfolio standard, there is no concern or implication about their
additionality, because it is the quota that drives the change. It's only in the
voluntary offset markets, where RECs are sold for their carbon benefits, that
their additionality needs to be tested. In theory, it does not matter if RECs
are sold as RECs or as carbon credits as long as they are not double-counted
and are additional. Yet in practice ensuring additionality is very difficult.

Voluntary-market RECs generally do
not have to adhere to the same strict additionality standards as carbon
offsets. Green-e, the largest third-party certifier of RECs that are sold in
the voluntary market, for example, requires that RECs have to come from
renewable energy plants that were built after 1997 and cannot be counted toward
renewable portfolio standards or any other legal requirements. Although these
two requirements are important, they do not fully address additionality.
Because of the economic benefits of many renewable energy projects, such as wind
farms, it is especially difficult to determine additionality with RECs. This is
not to say that none of the available RECs are additional, but there is
currently no standard and verification available that ensures additionality.

There are currently several
initiatives under way to streamline the voluntary market and ensure high
quality of the offsets generated outside of CDM. The U.K. government, for
instance, is developing a voluntary code of best practice that would certify
projects. In the United States, Representative Peter Welch (D-VT) has proposed
legislation that would allow government employees to buy offsets for their
travel emissions. That legislation would require that only government-approved
offsets could be bought. This in turn would offer the opportunity to develop a
U.S. standard for offsets. The World Wildlife Fund has developed a Voluntary
Gold Standard that is endorsed by 38 NGOs. Its strength is its focus on
stakeholder involvement and additional sustainability benefits. And the carbon trade
industry is developing a Voluntary Carbon Standard which would include a
central registry for all VERs to minimize double-counting.

In the best case this newly
emerging field, which many have likened to the Wild West, will over time
mature, and quality assurance will become an integral part of the market. Yet
this will only happen if consumers are educated and willing to push for higher
standards and more transparency in the market.

Many of us in the developed world
are still trying to absorb the lesson of the limits to growth that nature
imposes. It would be a serious mistake to see offsets as a comfortable way to
avoid the need to drastically reduce our consumption. The price that our
children and grandchildren will have to pay if we do not change our habits will
be tremendous. Yet if voluntary carbon offset projects can help spur change and
innovation, if they are just one of many climate protection measures
undertaken-cap-and-trade, carbon taxes, efficiency standards, smart city
planning, good public transportation, and so on-they could play a useful role
in guiding the world towards low carbon economies and at the same time help
achieve the Millennium Development Goals of alleviating poverty.

Anja Kollmuss works for the
Stockholm Environment Institute-USA, an independent research organization
affiliated with Tufts University. She did her study of voluntary carbon offset
companies while with the Tufts Climate Initiative. The study and her
recommendations for choosing an offset provider can be found at
www.tufts.edu/tci/carbonoffsets.